Musings from the Oil Patch
Given the outlook for the oil market, the authors believe there are three likely scenarios for OPEC members should oil prices go much lower (below $80 per barrel). These scenarios are: a price war forcing prices even lower; a period of internal repression may develop as oil revenues fail to enable governments to buy peace among the citizen populations; and internal unrest among producers, which could lead to supply disruptions followed by prices bouncing back up. The dilemma for OPEC is that high oil prices are driving growth in unconventional oil output and expanding the universe of oil suppliers. The technologies that have successfully unlocked shale gas resources are increasingly being directed to tight and shale oil resources with meaningful production outcomes. Because unconventional oil plays have much higher variable costs, supply is much more responsive to price in the short-term than was experienced with conventional oil plays. High oil prices will induce and maintain higher production, a phenomenon we are witnessing today. It is this new dynamic in the oil market that creates OPEC's dilemma. Its members need higher prices now and in the near future to forestall domestic unrest. At the same time, however, higher prices destroy demand and encourage growth in non-OPEC oil supplies that ultimately will lead to lower prices. OPEC needs the golden eggs of high oil prices and high oil revenues, but it needs them at a rate that may ultimately kill the goose. The question is the timing. According to the authors, one can look to the 1980s for a test of this thesis, and one finds that it required nearly 13 years from the first jump in oil prices in 1973 to the crash in oil prices in 1986. OPEC had tried to defend against the killing of the golden goose in 1982, but it failed four years later. The authors believe, and we concur, that current market forces would significantly compress that reality today.
Eoin Treacy's view “The cure for high prices is high prices”
has long been an adage in the commodity markets. The supply response prompted
by elevated levels and the coincident demand destruction such situations prompt
explains this phenomenon.
The political situation for a number of oil exporting countries complicates the situation. OPEC countries in particular have been notable for a failure to improve their standards of governance from a civil, economic and corporate perspective. A trend toward bribing their respective populations in order to retain a grip on power has been evident for decades. However, the situation has deteriorated to such an extent that it is becoming increasingly difficult to sustain this level of spending not least because of population growth and increases in per capita consumption of oil.
The Arab Spring exemplifies the failure of regional governments to manage the aspirations of their large young populations. Quite how they intend to appease demands for greater freedom represents a significant challenge. Internal repression, while effective, would appear to be a short-term solution that leads to more intense long-term issues.
Brent Crude encountered resistance in the region of $120 in September and has held a downward bias since. It firmed from the $105 area in October and returned to test the short-term progression of lower rally highs. A sustained move above $112.50 would now be required to check current scope for a further test of underlying trading.
West Texas Intermediate paused in the region of $90 on Monday and would need to sustain a move above that area to check potential for some additional lower to lateral ranging.